Staying Out of Trouble Overseas

By

Howard R. Gold

Aug. 18, 1998 7:31 p.m. ET

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An Interview with James L. Moffett. Foreign markets have been no place for the timid in recent months, but by focusing on the right places some investors have done well. One of them is Jim Moffett, who runs the
Scout WorldWide Fund
for UMB Bank in Kansas City. By focusing on highly liquid blue-chip stocks that trade as American Depository Receipts in the U.S., Moffett has kept his risk low while benefiting from this year's big run in European stock markets. In this interview, the Harvard grad with an MBA from Stanford tells how he finds good foreign stocks at reasonable prices.

Q : What is the reason for that? Why did you pick that sector to look at, to concentrate on?A : It reflects the bent we have to focus on high-quality stocks. Some of it reflects the fact that we are here in the Midwest, and these are the stocks we can get information on. We don't do a lot of travel. So we are not in a position to ferret out the little nuggets supposedly buried in Indonesia or something.

Q : You are not like Mark Mobius who spends half his life on planes between Jakarta and Bangkok . A : Right.

Q : Because ADRs have to follow GAAP and basically report just like U.S. companies do, it gives you more of the information you need to make those comparisons.A : I think it is important to understand that there are distinctions -- listed ADRs through the New York Exchange -- or other exchanges, for that matter -- have to follow U.S. GAAP accounting. But over-the-counter ADRs don't have to follow GAAP reporting.

Q : They don't have to follow GAAP?A : Right. That is why they are not listed, because they don't want to follow GAAP.

Q : Do you also buy those, too, or do you mostly concentrate on the ones that follow GAAP?A : We buy those, too. We have 70% [of the fund's assets] in ADRs. I would guess probably 30% of that is in over-the-counter ADRs.

Q : What do you look for when you want to buy one of these stocks?A : Basically the same criteria that we use in looking at domestic stocks. We start with a clean balance sheet, unusually good growth prospects, an attractive valuation. Beyond that, we look for some kind of a catalyst for change, like management restructuring.

Q : Do you look at price-to-book, price-to-earnings ratio? What kinds of things do you focus on?A : We have a model that we look at, which is price to book, price to sales, price to cash flow, even price to earnings. Also I use the dividend discount model. Probably price to cash flow, we feel, is most important.

Moffett's Picks

Q : Why?A : One of the reasons I like price to cash flow is it cuts through accounting differences. When you look at a Japanese company, on a cash flow basis it looks a lot more reasonably priced than it does on a price/earnings basis.

Q : So, you look for price to cash flow and you look for prospective growth, prospective catalysts. You also try to evaluate the management to some degree, don't you?A : We try to evaluate the management or look for management changes--companies like Alcatel in France, where new management has come in, and that is part of the restructuring story.

Q : You have focused primarily on Europe. According to a recent Morningstar report, about 60% of your assets is in European companies now. Is that about right?A : It is probably closer to 70%. Some of that bias is because that is where the well-established blue chips reside. Some of that is a feeling that the values in the other countries aren't that attractive. That is one reason we missed some of the disasters in the last year.

Q : Why such a heavy bet on European markets?A : The plus side is that we like what is going on in Europe. In the 1980s and early 1990s, the United Kingdom was undergoing a lot of the same transitions that we were, thanks to Margaret Thatcher. Now Western Europe has made some of those changes in a little less dramatic way. That is the plus side. The negative side is in some ways we were avoiding what we thought were overpriced and riskier parts of the world.

Q : So, last year you saw that there were potential problems in some of these markets?A : We didn't see a particular disaster happening, but the risk levels were such that we weren't comfortable being there. We run with about a 10% weighting in Japan. It has been our conscious decision that their stock market wasn't that cheap. They hadn't come to grips with their problems. Most of what we owned were export-oriented companies who were benefiting from the weaker yen.

Q : What about now? Are you still leery of Asia and Japan?A : We were looking at Japan. But we don't think they've turned the corner yet.

Q : So, you think that the time is coming when it might be right to invest again in Japan -- but not quite yet?A : Exactly.

Q : What will be the signal to you that Japan has turned the corner--when they finally get a grip on their banking problem?A : I think that is probably the biggest single factor. There are some changes going on under the surface, where managements are becoming more stockholder-oriented, more concerned about maximizing their returns on capital. When they had cheap capital, they didn't have to worry about it.

Q : Exactly. That is what people overlook -- that they had such cheap capital for such a long time.A : That is what permitted them to think long term, so to speak.

Q : But they thought long term about building market share -- not profitability.A : Right. And that is where the big change is coming from. They are thinking more in terms of profitability, deregulating their markets.

Q : What about the rest of Asia?A : At this point we are concerned about what is going on in China. Their economy is slowing down, their exports are slowing down. They have lost, in a sense, their competitive price advantage. There is a risk of devaluation.

Q : So, how would that impact the rest of Asia? If China devalues, do you think that would start another round of competitive devaluations?A : Probably. It doesn't have to, but it would probably put downward pressure on the yen.

Q : Let's turn to Latin America. You have only about a 5% position in Latin America. I understand you were a little leery of Mexico because of some political issues.A : Political and economic issues, we are concerned about Mexico.

Q : What about Brazil? The Telebras auction was a blowout, with a lot of interest from foreign buyers.A : We had a fairly substantial position in
Telebras
.

Q : Are you holding on to all 12 pieces of it?A : Well, we converted it into what are called the
HOLDRs
. [Editor's Note: HOLDRs represent a basket of securities in the 12 companies formed by the breakup of Telebras.] It is kind of the chicken way out. It gives us the time to sort out what the pieces are worth. We had bought some Telebras back in when we were worried about whether the auction was ever going to happen.

Q : And the stock hit a low of around 83 or something like that. I think now it is the equivalent of about 120-something at this point. The high was about 170 last year. What do you think about the rest of Latin America?A : We think Argentina and Chile have both made big improvements in how their finances are run and their politics. That is the upside. The downside is in many ways they are still a natural resource-based economy in Chile.

Q : Let me jump right into your stocks. As of the end of June your largest holding was SAP, which just got a listing on the New York Stock Exchange.A : That is kind of an exception. We bought
SAP
as an ordinary share in Frankfurt. One of the value things we saw potentially was that they would get a listing.

Q : Obviously the company is well known. People love their software--even Microsoft uses it. The growth rate has been over 60%. It is really quite phenomenal.A : It has been growing like a weed. We love them. You wonder at what point you want to quit loving them.

Q : Well, people who quit loving Microsoft a few years ago are probably kicking themselves now. It is hard to know when it is going to stop. But right now you still like it?A : We love it.

Q : How about Nokia? Why do you like that stock?A :
Nokia
is beating up the competition in cell phones.

Q : Namely Motorola.A : And
Ericsson
, too. We own some Ericsson too. But Nokia is the big dog in the business. We cut back on it a little bit just on a valuation basis.

Q : You have sold a little bit of it?A : Right. Taking some profits. That is a winner.

Q : So, do you still like them? Is this kind of a Hold at this point?A : It is a Hold at this point.

Q : That is a Japanese company.A : It is a Japanese company and it is not really a chemical company; it is a drug company. But it has some exciting new products coming on line. They have a tie with
Abbott Laboratories
to produce and market [some promising drugs]. They are an example of what I was talking about: companies that are starting to do a more focused job of trying to make some money; they're consolidating some of their foreign subsidiaries.

Q : So, you think this is an attractive company at this point . A : Right. It is a combination of restructuring and refocusing.

Q : Any ADRs you find particularly attractive right now?A : Some of the things that we like are in the beverage area, like
Diageo
.

Q : That's formerly Grand Metropolitan plc. They still own Burger King, don't they?A : Right, they still have Burger King. And some beverage operations. DEO is the symbol.

Q : The stock has been in a bit of a trading range from the mid-40s to the low 50s. The consensus earnings estimates for next year is $2.45; this year, it's around $2.10. That is about a 13% growth rate. And with the shares selling near 50, it is trading at about 20 times next year's earnings.A : Right.

Q : So it is at a bit of a premium to its growth rate. Not that great a premium, I guess. What do you like about this in particular?A : With its merger, it is somewhat of a restructuring story.

Q : Who did it merge with?A : They were primarily in the booze business.

Q : Was it Guinness?A : It is Guinness. And there is some overlap in their product lines and where they can get some economies out of it. As I remember, their earnings have been coming through better than expected.

Q : They also sold off Dewar's to somebody. I think they sold some things to Seagram.A : They had to do that to get antitrust blessing. Actually they got a pretty nice price for it, too.

Q : Anything else?A : A down-and-out stock that I want to buy more of is a Brazilian company,
Aracruz Celulose
. ARA is its symbol. They are listed on the exchange. We have a little position in it.

Q : It is really down and out. This thing was in the low 20s last year. It is now just below 10. In all honesty, the chart does not look so great. Its earnings surprise last quarter was -99%.A : Right. In the short run it is ugly.

Q : Why is it having a problem? Why do you think it can get through it?A : Around the world, the whole forest products industry is having problems.

Q : They are in the forest products business.A : Right. They are a pulp producer. They chop up eucalyptus trees. In some ways it is a hedge. If Brazil does wind up devaluing its currency, it would actually help Aracruz. Aracruz, we think, is a hedge on a [possible] devaluation in Brazil.

Q : Their earnings are expected to double next year, from about 67 cents for the current year to $1.27 for next year. But that is based on only one analyst who covers it. So who knows? At any rate the multiple is pretty low. I guess this is for people willing to bet that it is not going to go down much further. Any sense of what could happen next? Are you optimistic, pessimistic about the markets? A: We are a little cautious at this point. Our cash reserves are up. We always carry more cash than most funds. But we are carrying more than usual. Worldwide, things are kind of shaky.

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